**When Rule Maker announces an intention to trade, that trade will be made
within the next five business days, as opposed to the very next day. For
more detail on how buys are determined and how this portfolio originated,
please read the "11
Steps to Rule Maker Investing" section of the Rule Maker Portfolio.**

Editor's Note: This buy report was written by Dale Wettlaufer
(TMF Ralegh), the Fool's resident
financial stock genius. It was edited primarily by Tom Gardner. Dale's work
is impressive to say the least, and appreciated to no end. Dale took what
can be a complicated subject and made it accessible and useful for all --
and that's what Foolishness is largely about.

An Overview of the
Company

American Express is one of the largest financial services
companies in the U.S. and has what is arguably the best national and worldwide
mindshare positions in its industry. The company is best known for its American
Express Card, other charge cards (not to be confused with revolving-credit
cards, which it also offers), and variations thereof.

In many ways, the company is a membership-based marketer
that learns the who, what, where, how, and why its customers spend money.
It then markets to those preferences, aiming to make customers and merchants
happy. The combination is a powerful one that earns Amex about 2.5 cents
of every dollar its customers spend using the American Express card.

The company is also the dominant force in business
charge cards, with a market share of better than 50% of outstanding commercial
cards. While marketers of commercial VISA and MasterCard credit cards are
gaining ground, Amex has competitive advantages that have allowed it to defend
its position. We'll examine that issue in more detail below.
There's more to American Express than just cards, though. The company has
a financial management side to the business. American Express Financial Advisors
is the brokerage and asset management arm of the company. This is the sort
of business that the C-K Port knows well since its T. Rowe Price purchase
earlier this year. With approximately 9,000 brokers and account executives,
Amex has a little over half the number of brokers that Merrill Lynch employs
and is about 90% the size of Morgan Stanley Dean Witter.

American Express is also a huge travel services company, a sizable underwriter
of insurance, and is growing its Small Business Services unit, which provides
tax preparation, consulting services, and membership-based services to companies
with less than 100 employees.

A Concentrated Look at the
Business

For this investment in the Rule Maker portfolio, we are returning to the financial
services industry. We're already owners of T. Rowe Price Associates
(Nasdaq: TROW), a lean, mean asset management company. This time around,
we're going for something bigger. It's actually a competitor of T. Rowe,
as well as Citicorp (NYSE: CCI) and all the other huge financial companies
that have been in the news lately. Our newest investment, American Express,
is a natural for the Rule Maker portfolio.

The company is a cash generator, executes on its growth goals on a regular
basis, is rich in brand name awareness, and is successfully spreading that
brand name awareness around the globe to tap into growing markets. Since
1981, the company has delivered a total compound annual return of 17.9% versus
16% yearly for the S&P 500. Yep, these folks have delivered shareholder
value in the past -- and a lot over the past three years -- so let's look
at how they've done it and why we're willing to make a long-term commitment
to this company.

American Express has three business segments. The two major segments are
Travel Related Services (TRS) and American Express Financial Advisors; the
third segment is American Express Bank. Let's start with the Travel Related
Services segment, where we find a number of lines of business.

Travel Related Services

1. Charge Cards

American Express calls this the Consumer Card Services Group. Here's where
you find the famous green American Express card, the gold and platinum cards,
American Express corporate cards, and the company's relatively new revolving
credit cards, such as the Optima card. We make a distinction here between
a charge card and a credit card because Amex's major business function in
cards is to facilitate transactions, not to finance transactions.

Charge cards work this way: When you use your Amex card to make a purchase,
the merchant is removed from any credit risk in the transaction and they
know their bank account will be credited with cash within 1-4 days of the
transaction. To increase market share and maintain merchant loyalty, Amex
pays the merchant more quickly than the industry standard.

Think of American Express as a specialty lender. Amex is technically buying
a receivable -- the cardholder's promise to pay -- from the merchant, at
a discount. The other way to think about the company is as a transaction
facilitator. When an American Express customer makes a purchase, Amex pays
the merchant. The merchant receives cash within 72 hours from Amex, and Amex
receives payment in full or earned interest from the cardholder within 30
days of billing the customer. Amex's discount from the merchant typically
runs in the 2.5% to 3% area. In other words, if you buy a $100 scarf on your
American Express card, Amex then pays the merchant $97 to $97.50 for the
scarf, and then has to collect that $100 from you to profit.

At $5.7 billion, "discount revenue" was the largest single item on the company's
1997 revenue line and has posted the largest two-year compound growth of
any of Amex' billion-dollar businesses, at 12.7%.

2. Corporate Services, Small Business Services, and Travel

Corporate Services

Amex is also the largest issuer of corporate charge cards in the country.
This market is huge... and growing. According to the trade magazine Credit
Card Management, the size of the corporate market is around $600 billion
annually. An older article in the same magazine quoted various sources saying
that only 15% of this market was presently being addressed by corporate card
issuers. There's a lot of growth potential here.

We quote from the same September 1997 article from Credit Card
Management: "Amex has about 8.5 million commercial cards outstanding,
VISA about 4.4 million, and MasterCard 2.4 million. And some industry observers
say they expect the number of commercial cards and the charge volume to grow
as much as 50% over the next few years." Amex, VISA, and MasterCard have
traditionally marketed their services to corporations for travel and expense
accounts. The growth in commercial cards will come from pursuing opportunities
in the corporate-purchasing department market and in auto and truck fleet
spending.

One distinct advantage Amex has over the competition sits right there in
its Corporate Services unit. Corporate Services adds value to Amex's corporate
cards. John Reed, Chairman of Citicorp, has said that banking will become
"a little bit of application code in a smart network." What does that mean?
It means that the companies in the financial services industry that generate
the highest-quality shareholder return won't simply increase assets year
after year in a market share-grab. Shareholder value will come from adding
maximum value with minimal capital input to services that could otherwise
be described as commodity-like. This is where Dell Computer(Nasdaq: DELL), GEICO, and Home Depot(NYSE: HD) have succeeded. The products
are commodities; the service isn't. How Foolish.

The same thing goes for American Express.

The Corporate Services Group keeps track of, and helps direct, corporate
spending through its expense management systems. These systems link terminals
at merchant locations throughout the world with American Express's "closed-loop"
information system to track customer spending and preferences. For people
that are on the road a lot or that use a corporate card often, the services
that Amex offers makes their lives easier by offering automated, Web-based
expense reporting, travel planning that meshes with a company's preferred
programs, and Web-based account access. Early this year, Amex signed a deal
with Portable Software Corp., whose software accomplishes the above functions
and saves American Express corporate clients a ton of money in back-office
expense accounting. According to Amex's press release:

"Travel and entertainment (T&E) is typically a company's third-largest
controllable cost, and the average company spends an additional 5 percent
of its annual T&E budget just processing the paperwork related to expense
reports. A manual process costs the average company $36 per expense report,
according to a recent in-depth American Express study. Automating the process
can cut that cost to $8 or less and reduce the time employees spend per expense
report from 55 minutes to 15 minutes or less."

For clients such as Procter & Gamble(NYSE: PG), these projected
cost savings will be a huge selling point and will engender further customer
satisfaction.

Small-Business Services

Another growing part of American Express's Travel-Related Services Department
is its Small Business Services group. This is more of a business-to-business
segment that many consumers wouldn't see in their daily lives, but if you're
in the CPA profession, you definitely know about this company.

Amex has been buying up accounting practices in major metropolitan markets
for a number of years and now has 56 offices in 20 states. The Tax and Business
Services unit does tax preparation, tax planning, financial planning, consulting,
preparation of financials, pension administration, and bookkeeping. In short,
CPAs are terrified by this side of American Express, since our firm has the
chance to gradually "roll up," or consolidate, the accounting profession.
In fact, American Express offers to the public-market investor the only access
to a major national and international accounting and consulting firm.

Amex's Small Business Services group also acts as a membership-based marketer,
playing intermediary between small business and provider services, such as
FedEx, hotels, and rental cars. Amex takes a cut of the transaction and delivers
a good clientele to the merchant, and the Amex customer enjoys the discount
on the services. In fact, there are many similarities in this part of Amex's
business model to that of Cendant's(NYSE: CD) CUC International Unit.
It may seem hard to believe, but until recently there was a gap of only around
$10 billion in the value of Amex and Cendant.

Travel

Amex is the largest corporate travel agency in the U.S. and is among the
top three agencies, depending on customer segment. This has been a low-growth
area for the company over the last two years, but its value to the company
may be seen elsewhere. Since the company markets itself based on service
to customers, its bricks-and-mortar travel office presence and concierge
services are very important to its overall corporate strategy of offering
high value-added card services. Last year, Travel accounted for just under
12% of net revenues.

And now on to the second major component of American Express' business...

American Express Financial Advisors

The second large moving part of the company is American Express Financial
Advisors (AEFA), the former IDS. AEFA is the sort of company that we normally
make fun of since it offers lots of financial products with which we disagree
pretty strongly. Front-end and back-end load funds, annuities, and variable
annuities are some of our least-favorite investment vehicles. Amex's nearly
9,000 brokers are out there working hard to get their clients to buy their
proprietary funds, Amex insurance products, and plain old full-price brokerage
fare, making the company one of the larger broker/dealers in the U.S.

Despite our efforts to educate Fools on taking care of their own money, we
recognize that there are people that don't want to deal with the subject.
Financial planners and brokers, or account executives as they say, will continue
to do well marketing directly to their clients. The relationship approach
to saving and investing results in a yearly retention rate for Amex in the
90% range.

Amex is the 14th-largest asset manager in the U.S., with $71 billion in assets
under management. It is also a large custodian of financial assets, with
$100 billion in assets under custody. These are very high-return subsegments
of the AEFA unit that will continue to do well in the future if Amex can
compete well with larger competitors such as Fidelity and State Street
Corp. (NYSE: STT).

And now for Part III of American Express...

American Express Bank

American Express Bank (AEB) is primarily an overseas commercial bank that
operates as sort of a money-center institution in emerging markets. The bank
issues working capital and trade finance loans, provides clearinghouse services
to smaller correspondent banks, provides asset management and private banking
services to individuals, and provides capital markets and foreign exchange
trading for smaller banks and corporations.

Close to half of the company's credit portfolio is Asian and about half of
that portion of the business is made up of short-term business loans. The
company recently increased its credit loss reserves by an amount equal to
approximately 7.6% of the Asian portfolio, mostly for Indonesian businesses.

Though travelers' checks and other pre-paid products report as part of AEB,
their futures are intertwined with the Travel group of Amex, as are their
pasts. As we explained in a recent Fool on the Hill column:

"A customer comes in and hands over cash to Amex in return for a bundle of
travelers' checks. Between the time Amex issues the checks and the customer
spends them, Amex gets to keep that cash and invest it in loans, interest-bearing
securities, or other investments. Since Amex typically takes in more cash
each year for issuing traveler's checks than it has to pay out, and since
it doesn't pay interest on traveler's checks, the deposits are very much
like checking account deposits at a commercial bank. Checking account deposits
and other noninterest-bearing deposits at banks are called 'transaction
deposits,' which is intuitively what one might call the liabilities that
arise from American Express issuing traveler's checks. With an average of
around $6 billion in traveler's checks outstanding in 1997, the cash that
the company takes in for the checks could generate a minimum of $300 million
if invested in money market instruments."

While the future may be limited for the growth of travelers' checks (especially
in North America), the company has also been actively involved in the development
and marketing of stored value cards and smart cards. Smart cards are also
products that develop float, or cash, that American Express can use between
the time the customer is credited with the spending authority and the time
the money is actually spent. Amex will stay in the forefront of bringing
smart cards to market, as it's a natural complement, and eventually a
replacement, to its travelers' checks. Stored value cards and smart cards
are another way for Amex to build customer relationships and loyalty, as
well. These cards can be used for security functions, such as access and
authentication, fleet management systems, toll booths, and in closed-environment
needs, such as at Club Med, Disney World, or on military bases.

As we can see, Travel Related Services is the most productive part of the
company, with $12.7 billion in sales and a return on equity of nearly 28%,
compared to 20.5% for Amex Financial Advisors and 10.1% for American Express
Bank. The charge card unit drives the economics of the consolidated business.

The Basic Financials

Ok, we're going to be using some new language here as we delve into American
Express' business model and performance. Please know that we're just a click
away in the
Rule Maker Folder on the Web, ready to answer any questions you have about this
material. (And who says Fools can't provide full service?) Without pause,
then, let's leap into things and see what we come up with.

For starters, you need to know that many financial services companies take
a lot of capital to generate earnings. One way to measure the leverage on
the balance sheet is to look at the debt-to-equity ratio. But I think a more
reliable indicator in the financial services industry is a company's average
assets-to-average equity ratio (how much business the company has taken on
relative to its owners' capital base). Debt comes in various forms on a financial
services company's balance sheet. Not only is there long-term debt, but there's
a lot of short-term debt, commercial paper (including repurchase agreements),
and other instruments that span the spectrum between short- and long-term
obligations.

Among a group of 14 large financial services companies including Citicorp,
Chase Manhattan, and Merrill Lynch, American Express's average assets-to-average
equity ratio of 12.62 is below the average of 14.84, meaning it is not as
leveraged as its competitors. Leverage can also be expressed by dividing
the ratio by 1. One divided by 16.96 = 0.0590. So, the company has 5.9 cents
in equity for each dollar in assets it uses. Did you ever wonder why so many
S&Ls failed in the 1980s and 1990s? When you can buy $1 in assets for
five cents or less, things come crumbling down if and when the assets stop
producing income.

The difference between equity and assets on a balance sheet is debt. Therefore,
when you have five cents of equity for each dollar in assets, it means that
you have 95 cents in liabilities, since assets = liabilities plus owners'
equity. When the assets start to act erratically, that has a magnified effect
on the ownership interests in the company. When assets go sour, there must
be a corresponding reduction in the liabilities and equity side of the balance
sheet -- and that reduction comes out of the owners' interest in the company
before it comes out of the hides of the corporation's creditors. We therefore
want a set of assets with more predictable performance, which is what we
have in American Express' charge card receivables and highly liquid investments.

What mitigates the heavy leverage employed are two other ratios an investor
should pay attention to when looking at financial companies: Asset turnover
and net margin. Asset turnover measures how many times per year a dollar
of assets can generate a dollar of revenues. For the financial services industry,
this ratio is quite low, at an average of 6.7%. Looking at the inverse of
that number, 6.58% divided by 1.0 = 15.2. That means it takes 15.2 years
for a dollar of assets to turn into a dollar of revenues. Compared to that
average, American Express does very well for itself with an asset turnover
ratio of 14.74%. That means it takes just 6.78 years for a dollar of assets
to turn into a dollar of revenues. That's less than half the time it takes
competitors to turn over assets.

That makes the company's net margin lag bearable. With net margin of 11.83%,
American Express lags the rest of the industry by a considerable amount.
Long-term investors are looking at this part of the financial model to improve.
If Amex can keep up its faster pace of product development and its ability
to add unique value to its products, net margin should increase and bring
about not only an explosion in net income, but possibly higher valuation
multiples. American Express wants to be known as a growth company with ascending
margins.

Finally, return on equity (ROE) is the basic yardstick we use to measure
the performance of financial services companies. It measures the amount of
earnings the company can create for each dollar of equity capital invested
in the business. We would rather have a company that can grow its earnings
with a decent return on equity and a lower-than-average level of leverage
than by pushing leverage through the roof and jeopardizing our interest as
shareowners of the company.

We've put together this calculation for your Foolish application. It'll look
scary, but I think we can talk you through it (and down off the ledge)...

Multiplying the three produces return on equity of 22%. The end result is
that Amex's return on equity far surpasses the industry average of 17.55%
with less leverage and lower margins. Its secret is the fast turnover of
assets and intelligent use of its little leverage.

With that under our belts, let's look at the actual financials and move on
to a description of the business.

You've probably noticed by now that financial services firms work a bit
differently than the average company. The normal Rule Maker criteria don't
work that well for these sorts of companies because they can "create cash"
at will by issuing liabilities such as certificates of deposit or other
short-term debt such as commercial paper. Also, profit margins aren't as
important as capital efficiency, which we showed above in the calculation
of return on equity (ROE).

Our basic criterion for a Rule Maker company in the financial services industry
is ROE. A Rule Maker's ROE must be 50% greater than the cost of that equity.
Over the long-term, equity returns have averaged 11% per year, which makes
our hurdle rate 16.5%. Another way to identify a Rule Maker in the financial
sphere is that its ROE must be 20% greater than the industry average.

At 22% for Amex versus an industry average of 17.55%, it surpasses with ease
the 20.66% hurdle rate for ROE. Finally, as a generic rule, we want ROE above
20% per year in good economic environments and at least 15% in bad ones.
Though these measures don't carry the same certainty as the other C-K criteria,
this industry is different than others. The very good companies can have
their ups and downs during difficult environments, but we want the cream
of the crop in the industry -- the ones never falling too low in dark hours.

Second, we are turning around the standard ROE calculation. In the calculation
we did above, we recognized that higher leverage helps a company generate
a higher ROE. But not all high ROE measures are created equal. We want a
ROE that is borne of efficiency and productivity, not leverage. Our Cash
King ROE, or CKROE, turns leverage on its head. The higher the company's
leverage, the lower its score here. Leverage is risk. We don't want to reward
that. We want to reward efficiency. The algorithm used to score here takes
off from the standard ROE calculation and only changes the leverage component.
So that:

100 minus leverage score x Net margin x Asset turnover = CKROE

From our universe of large financial services companies that have little
insurance industry exposure (we look at these differently), the scores stack
up this way (looking at the number before the comma):

Unfortunately, the way some companies account for acquisitions throws a monkey
wrench into the works. The number after the comma takes goodwill amortization
out of the company's expenses and also removes goodwill from the company's
leverage score (subtract goodwill from assets and owners' equity). This second
method is the way an acquirer would look at the company, which is why we
have ranked the companies in descending order according to the second score.
While it may not change the relative rankings that greatly, for some the
adjustment does have a profound effect. Wells Fargo, for instance, moves
way up the list because of this adjustment due to its huge 1996 acquisition
of First Interstate, for which it paid cash and generated a ton of goodwill
that now has to be charged off the balance sheet.

While we don't want to come up with an arbitrary rule on what passes here
and what doesn't, we do want to see a Rule Maker within the top three slots
of a larger grouping of its peers.

When we look at a financial services company, we also want a company that
generates lots of float from its operations. For an insurance company, float
is generated because the insurance company takes in insurance premiums that
it holds until it has to pay out for insured losses sometime down the road.
In the meantime, it gets the use of the cash to invest. This source of capital
is very attractive for a number of reasons. If the company can generate this
float at no cost or at a low cost on a consistent basis, it's like very cheap
debt. It's an obligation for the company, but the burden of the capital does
not make itself apparent on the company's income statement.

Since the cost of this capital is also not directly observable on the income
statement and since the company has perpetual use of this capital, it has
the characteristics of equity rather than debt. Since it's tantamount to
equity but does not require the further issuance of common stock to generate
this capital, we can think of it as equity in our leverage ratios, too. Moving
it out of liabilities and into equity increases the equity base and by definition
decreases the leverage ratio of the company. Doing so would bring Amex's
effective leverage way below average, to about 7.7.

Noninterest income to total revenues is another measure we look at. This
should be over 50%. This is calculated by dividing noninterest income into
the sum of net interest income plus noninterest income. The denominator in
the ratio is revenue. We want a financial services company with diversity
in its income stream and a lack of dependency on making money on interest
rate spreads, or the difference between the rates at which a company can
borrow and lend money. The 50% relationship breaks down if the company's
net interest income is abnormally low, since noninterest income could easily
overshadow artificially low elements of revenues. This is something Cash
King followers will have to exercise their own discretion on. Looking at
a company's "Notes to Financial Statements," if net interest margin is below
2%, then the 50% statistic breaks down and probably shouldn't be used.

Some financial services followers will want to know why we didn't look at
return on assets (ROA). We have, actually. ROA = Asset turnover times net
margin. That's already encapsulated in the financial ratios we have coverd.

Where to From
Here

The continued sharpening of the marketing focus at Amex will be a key determinant
in the company's ability to grow market share. In 1997, American Express
gained charge card market share for the first time in a number of years due
to increased and well-fashioned marketing, a re-focus on revolving credit
cards, increased acceptance of Amex cards by merchants, tightly focused
membership rewards programs, and ever-improving commercial card marketing
and operations.

VISA, which claims market share of close to 50% in general credit and charge
cards, will continue to be our company's main competitor. As a subset of
VISA and MasterCard, companies such as Citicorp and U.S. Bancorp will provide
stiff competition for Amex as well. But until the competition can create
the same sort of excellent overlay of numerous services and brand-name
familiarity, our company will continue to outpace them. Included in Amex's
integration of excellence are the demographic intelligence on its charge
card products, its corporate back office cost effectiveness and capabilities,
total travel & entertainment planning presentation, and membership reward
programs, among many others.

In consumer cards, the momentum is clearly on Amex's side. The competition
is somewhat handicapped here because the federal government will probably
force VISA and MasterCard to drop rules preventing bank card issuers from
also offering the Amex card. A key marketing channel will then be opened
to Amex and should drive its market share above the 20% level. By asserting
itself in consumer cards in 1997, Amex's brand recognition is increasing.
Meanwhile, customers who come into the fold are being retained due to their
satisfaction with the product.

All of these trends bode well for the card business over the coming five
years -- and by extension, for our new Rule Maker filly.

Despite hitting a rough patch in emerging markets in 1997, Amex's array products
and services in global markets is well-positioned. Brand recognition is high
and American Express has the distribution capabilities to convert on those
opportunities. American Express Bank is positioned to grow in economies that
can reach national income growth rates in the double digits. As a commercial
lender, its business will be lumpy, but the relationships it builds will
feed other parts of the business, such as Travel Related Services.

In stored value products, Amex is following the strategy of providing
membership-based incentives and not just digital spending power. The other
card associations will probably take a shot at doing something with the marketing
data that is collected on a stored value card, but Amex is the undisputed
leader in knowing what to do with that customer data. In addition, stored
value cards will operate under the same business model that we see with
travelers' checks. In other words, they generate cash the company can use
at no cost. When we're looking at a Rule Maker financial services company,
that's our sweet spot. Float at no cost.

Small Business Services is a great growth area for the company, too. Though
it's a small part of the overall business, consulting and accounting practices
are light businesses that can be very profitable relative to the capital
they use. By the turn of the century, the company's accounting business could
reach half a billion dollars in revenue, according to industry sources, but
bring in almost twice the net income as American Express Bank.

With further enhancement of the value proposition the company offers in its
Travel Related Services business and a continuation of time-to-market advances,
the company could see an increase in its net profit margin. That will allow
American Express to scale back even further on leverage or, if it chooses,
to maintain its financial leverage to increase overall capital efficiency.
Either course of action will lead to healthy profit growth.

We believe that at its current valuation, the company provides a fine opportunity
to make an initial investment. As always here in CK-land, we're more concerned
here with the longer-term economics of the business than its present stock
valuation. Being that the company's merits lie in its capabilities as an
information-based marketer rather than as a capital-intensive financial services
concern, we're more than comfortable with the company's prospects and long-term
value in the global economy.

Is American Express a
Rule Maker?

We think so. But it's certainly a different sort of Cash-King. What does
it have in common with our other selections? It provides daily repeat-purchase
services, and it has a worldwide consumer name brand. The company also
aggressively manages its cash positions and operates a lighter business model
than its competitors.

But when we start looking at the numbers, the basic comparisons break down
because the business realities are so different in the financial services
industry. For this reason, I've used some new measures to assess American
Express against the competition. As discussed above, American Express comes
out looking very good on those measures.

And I believe that these wonderful Cash King characteristics will converge
in the company's stored value cards. These generate a low-cost to no-cost
float and deliver merchant and consumer data to Amex, which the company uses
to further tailor marketing programs to its customers' needs. In all of its
card products, Amex excels at figuring out the who, what, where, how, when,
and why of its customers. Its proprietary technology and financial services
infrastructure give Amex an excellent defense against competitors and serve
as a bases for expansion -- another set of characteristics we like to see.

American Express has all the hallmarks of a great Rule Maker company. It is
trusted by loyal customers; it runs a repeat-purchase business; it has light
upfront capital demands relative to the competition; it has the capability
to expand its franchise across the globe; and it turns out excellent returns
on the capital invested in the business. With the ability to internally finance
its global expansion, come up with new value-added services within its core
competencies, keep its current customers coming back, use the Internet to
its advantage, and find new growth areas that are spartan consumers of capital,
we look forward to market-beating growth over the long term from our Amex
shares. Time will tell, as it always does.